Filing 'Chapter 22' Becomes Enticing Option for Ailing Retailers

Struggling retail companies across the U.S. are shuttering their stores and declaring bankruptcy -- again.

Of at least 10 merchants to file for Chapter 11 protection from creditors in the past year, four are taking the trip to bankruptcy court for the second time in as many years.

While the ins-and-outs of bankruptcy are inscrutable to the average customer, at its heart the process exists to give beleaguered companies a fresh start free from crippling debt. The recent spate of “Chapter 22s,” as the industry sardonically refers to second filings, demonstrates an unpleasant truth in corporate finance: It’s not always enough to keep the companies alive.

After struggling to boost earnings after the financial crisis, retailers have been battered by declining foot traffic, the rise of big-box stores and the growing clout of Amazon.com. Many were further encumbered when they took on debt to fund private equity-sponsored acquisitions. The existence of repeat filers points not only to the depth of the retail crisis, but also to the tensions at play in any restructuring.

“Unfortunately, there’s a natural pressure to over-lever a company coming out of bankruptcy,” said Keith Maib, a senior managing director at turnaround advisory firm Mackinac Partners. “The old holders want to continue to be debt holders,” he said, which makes it difficult for a company to reduce the amount of money it owes.

Indeed, a study by a group of finance professors in 2009 found that on average, companies put through Chapter 11 reorganizations emerged from the process with higher debt ratios than their industry peers. Creditors’ priorities in the courtroom skew toward expediting the process and preserving their investments, the professors explained, which means their interests aren’t always in line with that of the company.

“Post-reorganization capital structures are often overly burdened with debt due to strategic negotiations among claimholders who generally are reluctant to give up senior claims,” the researchers wrote.

Data from the UCLA-LoPucki bankruptcy research database show that of 66 retailers that filed for Chapter 11 since 1979, only 40 emerged, with the rest liquidating their assets in the court process. Of those that did survive, 19 eventually ended up back in court.

Recent “Chapter 22” retail cases include that of American Apparel, which in late 2016 entered a second bankruptcy 13 months after its first, and Wet Seal, which in February filed for the second time in two years. Eastern Outfitters was sold in June to Sports Direct after its second bankruptcy in less than a year. And RadioShack in March began a second bankruptcy process, two years after emerging from its first.

“Previously, if you could right-size the capital structure and reduce the store base, that was the focus,” Gupta said. “What people realized is that they should have been taking a deeper dive. There has to be a very holistic, strategic review of the entire business if you -- as a secured creditor -- are potentially going to end up in the driver’s seat on this thing by owning equity.”

Liquidators have further pressured companies during bankruptcy, said Amir Agam, a senior managing director at FTI Consulting Inc. Professional liquidation firms are skilled at assessing inventories, and they bid competitively for the right to sell them. The liquidators establish a bottom-line value for a company in bankruptcy, and the retailer must prove it can emerge from a restructuring worth at least as much or more.

“These firms are repeat players; they do what they do well,” Agam said of the liquidation firms. “They’re better than the company at projecting what they’re going to get.”

At Risk

Hundreds of companies throughout history have filed for bankruptcy twice, according to New York University finance professor Edward Altman, who tracks repeat filers and helped coin the phrase “Chapter 22” in 1993.

And they don’t always stop there -- some companies have gone to complete third and fourth trips to the courtroom, as well as a single, remarkable “Chapter 55.” Strauss Auto took its fifth trip to bankruptcy court in 2012, 33 years after its first.

Several retailers currently at risk of bankruptcy, according to rating agencies, have been to court at least once in the past. Macy’s Inc., which is pursuing a large-scale turnaround as its profit margins shrink, underwent bankruptcy in 1992 after expanding too far too fast. Eddie Bauer, which first filed Chapter 11 in 2009, is seeking relief on its debt after seeing revenue and gross margins decline.

And after Kmart emerged from its 2002 bankruptcy to acquire Sears and rebrand as Sears Holdings Corp., the merged company is now selling off assets and seeking lifelines, including loans from its chief executive officer’s investment firm. The company burned through $251 million in the second quarter of 2017 alone.

Investors will be watching to see if the next chapter in the story of those companies is 22.

Struggling retail companies across the U.S. are shuttering their stores and declaring bankruptcy -- again. Of at least 10 merchants to file for Chapter 11 protection from creditors in the past year, four are taking the trip to bankruptcy court for the second time in as many...